Banks Lure Fintech Startups With Venture Funds

Citigroup, HSBC and Barclays stand in the Canary Wharf business, financial and shopping district of London, U.K. Many fintech startups are also in the space.

Bloomberg News

Surrounded on all sides by a bewildering array of new financial technology companies springing up, the big banks have responded with differing tactics. Several have recently come up with the most emphatic response yet—setting up their own venture capital funds to invest in the sector.

As a statement of interest, putting a few hundred million on the table is always convincing. Nor do big names hurt: Santander and HSBC are the latest to set up fintech venture funds. At this early stage what is less clear is how the funds will operate.

Spanish banking giant Santander in July announced a $100 million venture capital fund to invest in fintech start-ups globally, and a few months ago HSBC allocated up to $200 million for investment in early-stage tech companies with the aim of improving its technology.

Market participants welcomed the injection of cash but said such investment is not always trouble-free. Mark Beeston, chief executive and founder of a fintech-focused advisory and venture fund Illuminate Financial Management, said: “Anything that brings additional capital to the sector is, by and large, a good thing. It represents a strong vindication that the banks are recognizing they need disruptive technology models, and launching a fund is the strongest possible endorsement of this need to the marketplace. The challenge is really about implementation.”

Banks are taking a wide range of approaches in trying to keep up with the wave of technology innovation that is threatening to disrupt their sector. Last year two $100 million fintech funds were set up, SBT Venture Capital by Russian bank Sberbank, and BBVA Ventures, in Silicon Valley, by Spanish bank BBVA. Barclays this year launched an accelerator programme in London for fintech start-ups, while Swiss bank UBS has created a system of internal working groups with dedicated funding to work on specific technology projects, using individuals from the bank and external technologists.

From innovative start-ups seeking to compete with them on services such as online payments, to young companies developing solutions aimed at making financial institutions more competitive, there is a wealth of areas in which banks could benefit from investing in smaller players and getting insight into new tech developments.

Setting up venture funds is seen by many market participants as one of the boldest moves yet. Mike Powell, co-founder and partner at technology fund Thematic Capital and a former head of global markets at HSBC, said: “I think it’s a really good idea, it is a very smart initiative. If you don’t do something like this, then these things are going to pass you by.”

The HSBC and Santander moves reflect the general growth trend in corporate venturing in the U.K. A report by Silicon Valley Bank found that entrepreneurs in the U.K. plan to reduce reliance on angel funding and government grants, while increasing use of other funding types, such as corporate venturing.

Udayan Goyal, founder of fintech-focused investment and advisory firm Anthemis Group, said: “The best start-ups in financial services actually can get money from anybody, so the question is: ‘What does the bank bring to the table that a normal investor doesn’t have?’”

For a fintech start-up, accepting capital from just one bank could pose a problem. Venture capitalists often comment that a start-up and its existing investors might be wary of associating too closely with one financial institution, especially if the start-up is trying to offer services to the wider market.

Even if the finance is provided by a venture fund that operates at a remove from the bank that set it up, competitors of that bank might be suspicious of buying the services provided by a start-up in which the fund has a stake, making it difficult for the start-up to grow, argues Manu Gupta, a partner in venture capital firm Lakestar.

Lakestar is an investor in Algomi, a London-based fintech company that aims to make it easier for banks to match bond orders.

An early-stage investment by a large corporate may also limit future exit options for entrepreneurs and their investors, especially if the bank has negotiated a right of first refusal, advisers say.

But being backed by a big financial institution rather than more general investors does have benefits for start-ups in fintech. Such backing would be considered an achievement for many of these young companies, according to some market participants.

Unlike other sectors that have been disrupted by technology— such as book retail or travel— financial services has higher barriers to entry, because of heavy regulation and the need to build a strong sense of trust with users.

A bank investment or partnership can also bring a critical seal of approval and the access to a global distribution network.

Both HSBC and Santander were unavailable for comment at the time of publication.

This article was first published in the print edition of our sister publication Financial News dated July 28, 2014

About Venture Capital Dispatch

Produced by the editors of Dow Jones VentureWire, Venture Capital Dispatch tracks the fast-moving developments at the intersection of high-tech innovation and venture capital finance. Featuring the VentureWire reporting team in the Silicon Valley, New York, Boston and Shanghai tech centers, Venture Capital Dispatch provides insight into the newest start-ups and latest trends in venture capital investing. Write us at VCdispatch@dowjones.com. For more information on Dow Jones products covering venture capital and other financial markets, go to http://pevc.dowjones.com.